Revenue spells out tax trap to enterprise
The Inland Revenue has published new guidance on the taxation of family firms, informing husband and wife companies not to reduce their tax bill by taking a dividend payment.
The 49-page advice document enforces the taxman's controversial settlement legislation to "prevent an individual from gaining a tax advantage," through the transfer of assets.
It says the low-income partner should be taxed at his or her partner's rate of tax, which is more likely to be in the higher band tax rating.
Only when taking into account "the whole arrangement" of the taxpayer, can the Revenue choose where reduction of tax bills is legitimate and not under S600A.
It clearly states companies outside of liability, through their business structure, should not consider themselves outside the tax rule, which could indicate higher bills for almost 30,000 businesses.
"It has been argued that the unlimited liability of the partners means the settlements legislation cannot apply to partnerships. The Inland Revenue does not accept that.
"It is important, in relation to partnerships, to look at the whole arrangement to see whether someone is getting a disproportionate return on their contribution because they are related to, or friends with, the settler. If they are, then the legislation applies even if the partnership is being used."
Tax advisors say the timing to clarify S660A is interesting, given the forthcoming government paper on small business tax and the past 18 months of uncertainty for family firms, in the wake of the Arctic Systems ruling.
The Jones case wins an explicit mention in the Revenue guidance but assumes a stronger yet less obvious influence in shaping "some new" clarification for small businesses.
The IR explains: "When considering a spouse, the question in terms of the settlements legislation, is, 'what contribution does that spouse make and how commercial is the reward for it?
"The settlement legislation applies not only where there is a benefit for the settler's spouse but also where a settler retains an interest in the settlement, whoever the beneficiary might be."
"So for example, a husband who owns 100% of a company and grants preference shares to his wife, where those shares carry no voting rights and no assets in a winding up, has entered into an arrangement caught by S660A."
In a hypothetical tax situation, conjured up by the Revenue, it explains how if an unconnected part time secretary would be paid £5,000, but £45,000 is paid because she is also the settler's wife, then £40,000 will be his SA return.
It also attempts to explain what the Revenue sees an 'uncommercial salary' or 'uncommercial arrangement' and how this plays a part in any settlement decision.
"If an IT consultant was earning £80,000 a year when employed by a PLC and she then sets up her own IT consultancy and earns fees of £120,000 you would expect to see her drawing a salary of £80,000.
"If instead, her total salary is under £40,000 with £40,000 going to a non-working spouse that is likely to be an uncommercial arrangement."
The Revenue point out in the guidance that the settlement legislation is not scientific, but instead is a law applied depending on the "particular facts of the case."
Likewise, Contractor UK has learnt that some tax advisors perceive the guidance release as the Revenue's own interpretation of its own 1930s law.
"We have printed the document "A Guide to the Settlements Legislation for Small Business Advisors" from the Revenue website this morning," said Kate Cottrell, tax adviser at Bauer & Cottrell."
"It is 49 pages long and we have not read it all yet: All legislation is subject to interpretation and we have to remember that the guide published today is the Inland Revenue's own interpretation of this legislation. We also have to remember that Special Commissioners cases do not create case law precedent."
She told CUK tax advisors still faced uncertainty over 660A as the two Special Commissioners came to two different conclusions upon the rule's application.
The situation was compounded earlier this month, when top business advisors rejected the decision, deeming the use of the casting vote as invalid.
"We are pleased to see the Revenue's views set out in one document but Bauer & Cottrell will be waiting for the Pre-budget report and developments on the Arctic case before advising further."
One concluding paragraph in the mass of detail that is the Revenue 'guidance,' recommends a "simple test" to see whether a settler is inside 660A.
"Take a step back and consider, 'if I was working these arrangements with a third party would I be paying them these wages or dividends or sharing my partnerships profits in this way?' If the answer is no then the legislation probably applies."
Under the guidance, accountants and taxpayers are listed 21 enterprise examples where legislation does apply and 10 where it does not. Exactly what details need to be returned to the tax office are also included.
Anne Redston, tax partner, Ernst &Young, welcomed the guidance despite saying grey areas remain: "It is clear that the Revenue is going to come down hard on anyone that they think is trying to gain tax advantages by diverting income to another person."
"It's hard to know whether someone is within the rules or not. The list of examples are pretty clear but there are other situations, which we alerted the Revenue earlier this year, that are still not explained." An issue she said needs clarifying is how much work a partner would need to do to fall outside the rules.
The PCG added that the "guide fails to address key elements of the vagueness surrounding this measure and does little to mitigate the uncertainty for small family business owners."